WMA Cara Report for week ending Jan. 27, 2017

As U.S. equity indexes cruise past the one-year anniversary of the last equity market correction, many investors are getting more apprehensive. U.S. equity indexes are in rare air and Wall Street is stretching to come up with fundamental justification for prices at these levels to keep the game going. We have come to conclude that two things are certain in this most unusual market: (1) equity will one day sell-off again, and (2) no one will be able to predict what event will trigger sufficient concern among investors to shake them out of their complacency. This week the VIX index has traded below the 11.0 level for the first time since July 2014 and NYSE margin debt balances are set to pass the previous 2015 high of $500.4 trillion.Historically, equity corrections have been a hallmark of the stock market cycle. Although we are dealing with administered markets, as central banks refuse to step back, the duration since the last significant market pullback seems to be getting relatively long. We decided to look back over the past three bull markets to identify prior long dry spells for the Bears.Using the S&P 500, the table below compares the uninterrupted bullish market phases since 1990.

The current move high since February 2016 is rather unique in two ways. First, we have seen almost 12 months of higher prices and only one minor pull-back of -5% (shake-out post Brexit). Second, the current rally has occurred rather late in the overall bull market (the last bear market dating essentially from August 2011 when the S&P 500 came close to falling -20%).

If we exclude the nascent bull markets beginning following a -20% bear market, the average length of an “intra-bull” market run falls to 8.1 months. By this standard, we are already 4 months overdue for a -10% correction. In terms of gains for intra-bull market runs, the average percent gain falls to +28%, suggesting the current run is also nearing the end based on historical gains.

Another curious feature of the one-year bull run is the regularity. We saw prior to the tech bull top in 2000 numerous shake-outs of at least -5% as traders fought to stay invested without getting caught in the downdraft. Today, we have seen no significant pull-back since Brexit. Certainly this is attributable to the steady hand of central banks. Nevertheless, the slow, steady grind higher in the face of mounting incertitude with the new U.S. president leaves an eerie sense of calm.

 

Conclusion

Complacency has been profitable of late as equity markets grind higher without any threat of selling. Historically, however, buying with the VIX at extreme low levels as we see today has tended to produce negative returns for investors on a one to three month horizon. Trading equities today is akin to a game of hot potato – investors left holding equities at the wrong time will certainly get burned. Look for this period of complacency to end violently and in an unexpected manner.